Heaven knows I've made blunders like that, but I looked again, and it looks to me as if it's about 58% bonds at age 65. But "more aggressive than the aggressive curve" is being unreasonably over-precise, let's just say it's near the aggressive end of the range.

My spreadsheet for 41 years (72 to 12) using Simba data ... the steepness of the efficiency frontier is not that impressive

Well, that's the thing about investing enthusiasts of any stamp. They like to talk about direction rather than magnitude, because the magnitude differences are too small to take seriously. But, they say, "it's HIGHER! Which would you like, more money, or less money?" And then of course they take the tiny difference and compound it out for thirty years. And, yes, I think that applies to costs as well. The difference between a Vanguard 0.10% ER and a Fidelity Freedom 0.75% ER is minuscule compared hundreds of random life events, like spending nine years in grad school (me) versus six.

(ok ... I data mined ... LTT did great during this period ... I excluded emerging markets which did great ... who knows the future, both these assets will probably do worse in the next 41 years than the last 41 years ... particularly LTT ... again, who knows) ... that said, the risk reduction from bonds is likely to stay.

Oh, it's fine as long as you cranked in the phonus-balonus first. It's only data mining if you actually peek at the results and they come out wrong so you change the portfolio or the endpoints after peeking.

(And yes, I think people do that. I really do think that people used to say "EAFE adds hugely beneficial diversification," and then when the results started to come out wrong they pretended they'd never said that and just did a switcheroo to "International including emerging markets." And that when "small" came out wrong they pretended they'd never really claimed there was a small-company effect and made a switcheroo to small value. And from "value" to "value ex-utilities." Just like the people who believe in the Hindenburg omen keep refining and changing the definition, so that the current definition is always highly predictive of the past even though past definitions weren't.)

Last edited by nisiprius on Sat Feb 09, 2013 12:45 pm, edited 1 time in total.

I don't think people are talking about increasing stock allocation because the market hit a new high. It is because safe assets are expected to return so little. Right now 30-year TIPS have real YTM = 0.534% and 10-year TIPS are yielding negative, -0.592%

In 40-years at those rates, $100 will only grow to $108. You would have to save close to 50% of your income to be able to fund your retirement. So that is one option, save 45-50%.

Another option is invest in stocks that have long-term expected real return in the neighborhood of 4-5%. Then you only need a saving rate of 25%.

This is still worse than historical average. When stocks return 6.8% real and bonds 2% real, you only need a savings rate of 10-15%. So young investors in 2013 still need to save twice as much as they did in 1983. That is just the reality during an era of financial repression and asset inflation.

Believe me, if 30-year TIPS were yielding 2.5% like they were a couple of years ago, there would be threads about buying TIPS, like there were a couple of years ago.

grayfox wrote:I don't think people are talking about increasing stock allocation because the market hit a new high. It is because safe assets are expected to return so little. Right now 30-year TIPS have real YTM = 0.534% and 10-year TIPS are yielding negative, -0.592%

In 40-years at those rates, $100 will only grow to $108. You would have to save close to 50% of your income to be able to fund your retirement. So that is one option, save 45-50%.

Another option is invest in stocks that have long-term expected real return in the neighborhood of 4-5%. Then you only need a saving rate of 25%.

This is still worse than historical average. When stocks return 6.8% real and bonds 2% real, you only need a savings rate of 10-15%. So young investors in 2013 still need to save twice as much as they did in 1983. That is just the reality during an era of financial repression and asset inflation.

Believe me, if 30-year TIPS were yielding 2.5% like they were a couple of years ago, there would be threads about buying TIPS, like there were a couple of years ago.

I think it's fine to have a high stock allocation when you are young and Saving......then this thread morphed into having a high stock allocation when you are already retired! That's where I parted company.

Cut-Throat wrote:I think it's fine to have a high stock allocation when you are young and Saving......then this thread morphed into having a high stock allocation when you are already retired! That's where I parted company.

Agree, for most people, by the time you are retired you should already have shifted some of the stock into safe assets like Treasuries or CDs. Maybe 40% to 60% in bonds.

The only exception I can think of is if you have so much money compared to your spending needs. Like if you were retired with $4 million and only need to spend $40,000 per year. If you had 100% in S&P 500 you would only be spending 1/2 the annual dividends.

YDNAL wrote:There are 2 pages of discussion mostly centered on assumptions made based on historical numbers - and my position is quite clear on this... heck my signature says it all, so I don't care to proliferate that sort of conversation.

Instead, I want to show how as lenghty threads with lenghty posts go on, erroneous statements go unnoticed and not corrected.

Vanguard's target retirement offerings assume "retirement" at 65 and provide options for savers/investors as early as 18-19 year olds with about 47 years (TR 2060) to retirement. Up to 27 years to retirement (TR 2040), or 38 years old, ALL offerings are designed by Vanguard with a 90/10 Equity/Fixed split; then, progressively reduce investment in Equities over the NEXT ~ 27 years. Now, TR Income - or 30% Equity allocation as posted by Cut-Throat - is intended for those savers/investors whom have been about 5 years in retirement (about 70 yo).https://personal.vanguard.com/us/whatwe ... tWT.srch=1

You are either not familiar with what I just wrote in the previous paragraph, or just casually make incorrect statements as focusing in historical data and other issues tend to cloud reasoning.

YDNAL,

Just read what I wrote. For the circumstances I outlined, I am not a fan of 30/70 allocations, especially today. But I also said I don't know anyone's personal situation so I cannot say what is best or what makes the most sense for them.

Eric

Last edited by EDN on Sat Feb 09, 2013 12:45 pm, edited 1 time in total.

Maybe "anchor" isn't a good word. What I mean is, 60/40 is sort of a starting point for me when I meet with someone new and am thinking about what my recommendations will be -- 60/40 seems to work well for a wide variety of what I think are "typical retirees" (a 3 decade retirement wishing for about 4% per year and the desire to leave portfolio to next generation). Less in stocks if they don't need as much income or don't have any legacy goals. More in stocks is they put a greater emphasis on growing the bequest.

I find it helpful to start somewhere and adjust upward/downward according to objectives than be all over the map or start with all-bonds and always work up to a better mix.

Just to be perfectly clear. By "typical retiree" and "3-decade retirement" I assume you mean about age 65? If so, is this an accurate statement: "When I meet with someone new, my starting point for discussion is a stock allocation that is more aggressive than Morningstar's aggressive model glide path, and I adjust downward or upward from there?"

That is, is it factually accurate to say you start the discussion by suggesting a stock allocation that is 20% more of the portfolio than Morningstar's "moderate" allocation?

It would be factually accurate for me to say I have no idea what Morningstar "suggests" as their boilerplate asset allocations or retirement indexes-- be it the allocations (until you posted that chart), asset classes, how to rebalance or how the plan should evolve. I also don't know what Lipper, Litman Gregory, or any other purveyor of active management says is the best portfolio for retirees. At best, using these sources should be one minor input in the consideration process. But in general, I am not a fan of one-size-fits all. Even if I wanted to use them, how accurate would they be for how I construct portfolios (stocks and bonds only, small/value tilts in equities and ultra-high quality fixed income)? Depending on the type of bonds used, a 60/40 (with 5YR T-Notes) could have less downside than a 50/50 using other allocations (junk bonds, EM debt, etc.).

When I build a plan for a couple in their early 60s who is retiring/retired, I am aware that one of them might not be living in 10-15 years and the other may be around for the better part of 3 decades -- or neither of those may happen. But we try to prepare for as many realistic "what-ifs" possible. We cannot predict the future so we try to assemble a plan that achieves their ongoing income and legacy objectives (again, most/almost everyone I talk to would like to create multi-generational wealth and don't set out to deplete their assets in their lifetime) and doesn't catch them off guard with a short-term decline so extreme it was completely unexpected. And while we do rely on historical data for its perspective, we also recognize where it falls short today (bond returns are likely to be much lower than historical averages). Its just a process we talk through upfront and on an ongoing basis, as opposed to using some retirement questionnaire and just painting by numbers.

Eric

EDIT: this article from WBern (http://www.efficientfrontier.com/ef/404/grail.htm) is one of my favorite on fund-of-funds (and one-size-fits all allocations) vs. self-designed portfolios. In particular it shows a chart of different allocations and the different risks/returns they've achieved -- even for two portfolios of the same stock/bond split.

Last edited by EDN on Sat Feb 09, 2013 1:21 pm, edited 1 time in total.

The video uses stocks (CRSP 1-10) and t-bills, but at 1% real returns for bills, that's probably a good bond proxy today.

Loosely quoting Booth: "what i conclude is it isn't surprising that many investors choose a portfolio that is 60% or 70% in stocks, over the long-haul it will provide the real returns they will need to maintain the standard of living they want while dampening some of the standard deviation of stocks. Its easy after the last 10 years we've lived through to just focus on investment risk, but we shouldn't lose sight of the bogey long-term which is positive real returns."

Cut-Throat wrote:I think it's fine to have a high stock allocation when you are young and Saving......then this thread morphed into having a high stock allocation when you are already retired! That's where I parted company.

Agree, for most people, by the time you are retired you should already have shifted some of the stock into safe assets like Treasuries or CDs. Maybe 40% to 60% in bonds.

The only exception I can think of is if you have so much money compared to your spending needs. Like if you were retired with $4 million and only need to spend $40,000 per year. If you had 100% in S&P 500 you would only be spending 1/2 the annual dividends.

Greyfox,

It is fairly common for a successful small business owner to stay involved in that business in some capacity for their entire life -- continuing to draw an income more than enough to live on. So the investment assets become solely a vehicle to assist future generations and exclusively in equities. I have clients in this situation--will never touch their portfolio, they make their kids' ROTH contributions, contribute to grandchildren 529 plans, etc. Very generous and just a joy to work with. And far from feeling "entitled", next-gen family members want to build on the precedent that has been set where possible.

Risk ability - able to handle the perhaps permanent hit financially if it shows up, like say Japan nikkie 225 drop circa 1990 to now. Do not conflate expected average return with actual return paths, which may be horrible, during your financial lifetime.

Then sure.

But you are ignoring, that most likely expectantly a mix of say 10 bond 90 stocks would be better in any regard, certainly sharpe ratio wise, and possibly expectantly simple return wise as well with rebalancing......

100 percent of anything, likely not best expectantly. Now if you are young, just starting, sure go 100 percent if you want.

I would say take now sp500 level now, line it up to the 40k nikkie 225 level circa 1990, and project it out including dividends, to now, and if you are ok with that 23 year performance, then fine go 100 percent at 49...... Because certainly that is a very reasonable path we may take.

Reasonable meaning after the fact, a third grader on cnbc could make a great case why it was inevitable that it happened ex post.

Risk ability - able to handle the perhaps permanent hit financially if it shows up, like say Japan nikkie 225 drop circa 1990 to now. Do not conflate expected average return with actual return paths, which may be horrible, during your financial lifetime.

Then sure.

But you are ignoring, that most likely expectantly a mix of say 10 bond 90 stocks would be better in any regard, certainly sharpe ratio wise, and possibly expectantly simple return wise as well with rebalancing......

100 percent of anything, likely not best expectantly. Now if you are young, just starting, sure go 100 percent if you want.

I would say take now sp500 level now, line it up to the 40k nikkie 225 level circa 1990, and project it out including dividends, to now, and if you are ok with that 23 year performance, then fine go 100 percent at 49...... Because certainly that is a very reasonable path we may take.

Reasonable meaning after the fact, a third grader on cnbc could make a great case why it was inevitable that it happened ex post.

LH,

Not to quibble, but MSCI Japan is about -2% per year since 1989 (those nikkie price charts are the most misleading exhibit in finance) on a backdrop of 0% inflation to deflation. Not sure that is a "permanent hit". Japan small and value stock returns are in the 3% to 6% range over the same period, and conceivably no one should be 100% domestic equities. But even if they were, what a great DCA opportunity for an investor!

And would they have capitulated at some point? Maybe so, but that's less-likely to be the fault of 100% stock and more a symptom of general bad investor behavior. I'm just not buying that 10% or 20% in bonds and that razor-thin reduction in volatility is the only thing keeping sensible investors from destroying themselves.

I'm not saying every young person should be 100% stocks, but the benefits of 10% to 20% bonds is pretty minimal.

EDN, I'm 80/20. I feel the benefits of 20% bonds is huge, but perhaps the benefit is predominantly psychological. When the market tanks, I have the bonds available for rebalancing. And the opportunity to do something that is actually worthwhile is very valuable. I think the small amount in bonds helps keep the investor disciplined and helps build the psychological muscles to stick with a plan. Although the difference between 100/0 and 80/20 may not show up much with regard to SD and expected return, I believe the difference is huge with regards to psychologically and investor behavior. When things head south there is such a strong temptation to "do something". When 100/0 "something" is likely to be throwing away the plan. At 80/20 or 90/10 "something" is sticking to a plan, rebalancing, and building the fortitude for long run success. Besides, 100/0 is just not as efficient as one could be.

EDN wrote:Not to quibble, but MSCI Japan is about -2% per year since 1989 (those nikkie price charts are the most misleading exhibit in finance) on a backdrop of 0% inflation to deflation. Not sure that is a "permanent hit". Japan small and value stock returns are in the 3% to 6% range over the same period, and conceivably no one should be 100% domestic equities. But even if they were, what a great DCA opportunity for an investor!

And would they have capitulated at some point? Maybe so, but that's less-likely to be the fault of 100% stock and more a symptom of general bad investor behavior. I'm just not buying that 10% or 20% in bonds and that razor-thin reduction in volatility is the only thing keeping sensible investors from destroying themselves.

I'm not saying every young person should be 100% stocks, but the benefits of 10% to 20% bonds is pretty minimal.

Eric

On your larger point - 20 percent in bonds bumps sharp up 5 to 10 bp and Sortino up double that should not be ignored ... volatility reductions are minimal - but so is the impact on historic returns. Heck, as I posted above, you can backtest a reasonable portfolio when returns with some bonds (particularly LTT / ITT) are higher than 100 percent. I guess this disagreement is what makes a market.

EDN wrote:It would be factually accurate for me to say I have no idea what Morningstar "suggests" as their boilerplate asset allocations or retirement indexes-- be it the allocations (until you posted that chart), asset classes, how to rebalance or how the plan should evolve. I also don't know what Lipper, Litman Gregory, or any other purveyor of active management says is the best portfolio for retirees.

Just to be clear, it's not Morningstar's traditional mutual-fund-evaluating wing, it's actually Ibbotson Associates, which Morningstar acquired recently. So attacking Morningstar's active-fund-evaluation methodology, richly deserved though it may be, is irrelevant.

in general, I am not a fan of one-size-fits all.

Well, Ibbotson/Morningstar isn't trying to fit one size to all. That's my point: they show three fairly widely different glide-slopes--aggressive, moderate, and conservative.

Look, appealing to authority, which is what I plead guilty to, doesn't take anyone very far. I'm skeptical myself and I cheerfully ignore eminent authorities when it suits me, up to and including John C. Bogle. So feel free to dismiss Ibbotson/Morningstar's approach, just say that you're doing it--that Ibbotson/Morningstar's models are crazy conservative.

They give a sort of glossy-brochure presentation of their methodology here.

Also, keep in mind most of this talk today (Of higher Stock Allocation) as grayfox indicated is because bonds have such poor returns going forward. But keep in mind, if interest rates rise dramatically and bonds do take a 'big hit', stocks will probably get punished just as bad.

Cut-Throat wrote:Also, keep in mind most of this talk today (Of higher Stock Allocation) as grayfox indicated is because bonds have such poor returns going forward. But keep in mind, if interest rates rise dramatically and bonds do take a 'big hit', stocks will probably get punished just as bad.

This is certainly plausible (I wouldn't go as far as "probably").

or

GDP grows 3 or 4 percent - earnings go up - the Fed stops priming the pump and rates go up while stocks take off.

or

GDP shrinks just a little more than last quarter and the unemployment rate continues to climb as it has done in very recent months - prices then fall - we are in a Japan like spiral and the ten year yield is cut in half.

[snip]...My guess is Vanguard runs that fund first and foremost for ultra-low short-term volatility (what some retirees refer to as "risk"), and worries less about long-term real returns and the purchasing power of that income stream (what retirees should refer to as "risk").

Eric

I wholeheartedly agree with Eric's "what retirees should refer to as risk" line of thinking. While panic over market-drops may be a real psychological concern, it isn't the 'risk' you should worry about.

To parphrase Warren Buffett:

The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.

Investments that are denominated in a given currency, like bonds, are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

I believe that over any extended period of time investment in productive assets, whether businesses, farms, or real estate will prove to be the runaway winning category. More important, it will be by far the safest.

[snip]...My guess is Vanguard runs that fund first and foremost for ultra-low short-term volatility (what some retirees refer to as "risk"), and worries less about long-term real returns and the purchasing power of that income stream (what retirees should refer to as "risk").

Eric

I wholeheartedly agree with Eric's "what retirees should refer to as risk" line of thinking. While panic over market-drops may be a real psychological concern, it isn't the 'risk' you should worry about.

To parphrase Warren Buffett:

The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.

Investments that are denominated in a given currency, like bonds, are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

I believe that over any extended period of time investment in productive assets, whether businesses, farms, or real estate will prove to be the runaway winning category. More important, it will be by far the safest.

Bob

Can someone elaborate on the underlined section in the Buffet quote above? What risk is he referring to, single-currency denomination? This would seem to fly in the face of the usual position here, which is that securities in other currencies are more risky.

Call_Me_Op wrote:Can someone elaborate on the underlined section in the Buffet quote above? What risk is he referring to, single-currency denomination? This would seem to fly in the face of the usual position here, which is that securities in other currencies are more risky.

“They are among the most dangerous of assets... Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal.

I do not think he belongs to the school of thought that only the U.S. is on the road to perdition, and the rest of the world is blessed with fiscal responsibility and sound currency, so foreign currency is the best protection against inflation. His remark about "many countries" suggests to me that he is sour on all bonds, foreign as well as domestic.

Just read what I wrote. For the circumstances I outlined, I am not a fan of 30/70 allocations, especially today. But I also said I don't know anyone's personal situation so I cannot say what is best or what makes the most sense for them.

Additionally, "larger growth stocks" and such is biased and a personal opinion (please don't mention historical data we all know) - and this opinion is contracdicted when you say that individual circumstances should dictate what each of us do (or don't do).

There is nothing inconsistent about the viability (or lack there-of) of a particular allocation for general objectives while also specifying that not everyone has those general objectives, and therefore the conclusions don't hold for everyone.

Now, if you want to make the case that a 30/70 (TSM/TBM) today represents the best allocation for retirees with the general objectives I stated, I'd be very interested in hearing it.

SC Hoosier wrote:In their book "The Elements of Investing", one of them, not sure which, say that investors with high risk tolerance can be 100% equities up to 50 years old. I subscribe to this view as well. What are your thoughts?

I don't think this is right for any reasonable assumptions about expected returns and correlations. Some bonds are always helpful, and based on Sharpe ratios, most people don't have nearly enough.

staythecourse wrote:Nothing wrong at all with being heavy on equities. Period. The data supports it. Anyone saying anything else is suffering from recency bias.

I crunched the numbers of a heavy equity investor (80/20) vs. a defensive investor (50/50) over every 10, 15, 20 year period from 1926 to current. The data CLEARLY supports the equity heavy investor and only increases over the longer time horizons. In 10 year periods the 80/20 investor outperformed 80%+, in 15 years periods they outfperformed 85%+, and in 20 year periods they outperformed 95%+. Of course, folks out there will clamor about "what about risk??" The answer of WORST underperformance when it didn't outperform was 20% less returns in 10 year periods, 15% less returns in 15 year periods, and <5% in 20 year periods.

The data is the data. The job of every investor is to determine extrapolate that information for their personal situation. In my view of investing in general is: it is a matter of weighing PROBABILITIES vs. POSSIBILITIES. The probablities of success and REDUCING underperformances is with the equity heavy portfolios and only increases with increasing time horizons. THe possiblities of failure and crashing and burning is there, but that is not evenly remotely the likely possiblity. So, the question remains is do you invest based on high probabilities or the low possibilities. The former is using a rational approach and the latter is more emotional. Either is fine, but every investor has to answer that question themselves.

This does come with the caveat that any investor considering high equities: Have a recession resistant job (trust me not many folks fit into this), long time horizon, and no need for the liquidity of those $$ before the date of retirement.

Good luck.

This calculation misuses the data because you are increasing both risk and return. To make a proper comparison, you have to adjust the leverage on the more conservative portfolio so that it's risk equals the risk on the more aggressive one.

In risk-adjusted terms, you are losing out by shifting that heavily into equities. The return difference between a fairly conservative portfolio (esp. with value and small tilts) and a very aggressive one doesn't begin to offset the increased volatility and isn't nearly as much as people seem to think.

Furthermore, the leverage isn't merely hypothetical, if the returns from the more conservative portfolio are not sufficient, it still has a higher sharpe ratio. So you can always leverage it up to where the returns will be high enough (and the risk will still be less than the risk on your equity heavy allocation).

nisiprius wrote:A critical factor is: what do real investors really do when stocks drop? I've seen the same throwaway statement in several places, notably Chuck Jaffe's column, where he said here that

Chuck Jaffe wrote:studies show that average investors bail out when losses move beyond 20%.

I've seen this elsewhere, but always as a throwaway, never citing a source.

It's very important to know the numbers here, the range, and how one can tell how one personally stacks up against the average. Some silly questionnaire simply asking " If I owned a stock investment that lost about 31% in 3 months, I would..." doesn't hack it. One might as well ask people "Are you a) a man, or b) a mouse?"

Being able to stick with your allocation is *very* important. Studies of actual investor accounts show that the amounts they lose to bad market timing, etc. essentially dwarf the return premium to stocks.

am wrote:Thought 80/20 has a better risk adjusted return, plus you can get some additional return from rebalancing.

I don't object to the risk of 100% stocks but the ability to rebalance outside equities has got to be worth something! Rebalancing is one of the cornerstones of the whole Bogle approach.

Rebalancing is about controlling risk. If you have chosen to be 100/0, you don't need to rebalance (though potentially between your various stock funds you might). Also, as you can see, there is nothing special about holding mostly stocks and some bonds. On the otherhand, it probably doesn't make sense to be 100% bonds.

In the very long run, the stock market can't grow faster than the US economy, so whatever the equity premium is, it is probably much closer to 3-3.5% than the 5% that people typically assume. But this 3.5% figure is too high if you are 100% stocks because it is an arithmetic average. Your geometric returns from being 100% stocks will be about 2% lower because of the volatility. So your *expected* CAGR for 100% stocks is *optimistically* 1.5% higher than the 1 month treasury rate; i.e. about the same as the current premium on treasuries in the 7-10 year range.

If you have both stock and bond investments however, you can rebalance and get the one free lunch in finance. By regularly rebalancing, you can make your CAGR be much closer to your arithmetic return. These benefits are a *substantial* portion of the expected return premium to stocks.

Beyond that, the US was by far and away the best stock market of the 20th century. Academic estimates of surviorship bias and the effect of unobserved, low-probability "peso problem" events reduce the equity premium by another 2-3%. Finally, while taxes are at historic lows today, there's no way to guarantee that will be the case in the distant future. Historically, taxes have reduced annual stock returns by between 0.5 and 2% (and since they reduce the returns to both bonds and stocks, this makes the premium of stocks over bonds smaller).

IOW, yes bond yields are low right now, but there's no reason to expect that they are abnormally low relative to what you can expect equity investments to return. Bonds are worth having for the rebalancing benefit alone, and you'll be very glad you had them if the market goes no where for an extended period of time. (As it has done several times in US history and plenty more in the rest of the world.)

It may also be worth noting that if you are purely passive, then your allocation would be based on market cap.

According to this webpage. The US bond/stock percentages based on market cap is 63.4/36.6. If you go globally the weights are 74.1/25.9. So, for what it's worth, most people here are significantly over-weighting stocks relative to the market.

Or, looked at another way, the yield on 5 year treasuries is .92% and we can estimate the stock market's return at say 3.3%. Based on the recent (1996+) performance of the relevant Vanguard funds, we can estimate the annual standard deviations to be ~5% and ~17%. Assuming they are uncorrelated, the highest sharpe ratio occurs between 75% and 80% bonds. If we can reduce the stock portfolio's standard deviation by ~30% without impacting returns (there are various ways to do this), the maximum sharpe ratio occurs between 60% and 65% in bonds.

Last edited by Akiva on Thu Feb 14, 2013 1:09 pm, edited 1 time in total.

steadyeddy wrote:It broadens my thinking to read the diverse perspectives here. Healthy tension keeps us all on our toes, and I typically come away with increased conviction that I don't know what the future holds.

Ed:

Knowing what we don't know is an important attribute of a successful investor.

Akiva wrote:It may also be worth noting that if you are purely passive, then your allocation would be based on market cap.

According to this webpage. The US bond/stock percentages based on market cap is 63.4/36.6. If you go globally the weights are 74.1/25.9. So, for what it's worth, most people here are significantly over-weighting stocks relative to the market.

Or, looked at another way, the yield on 5 year treasuries is .92% and we can estimate the stock market's return at say 3.3%. Based on the recent (1996+) performance of the relevant Vanguard funds, we can estimate the annual standard deviations to be ~5% and ~17%. Assuming they are uncorrelated, the highest sharpe ratio occurs between 75% and 80% bonds. If we can reduce the stock portfolio's standard deviation by ~30% without impacting returns (there are various ways to do this), the maximum sharpe ratio occurs between 60% and 65% in bonds.

And using the Pythagorean approximation for CAGR, the expected difference in CAGR between a 75/25 portfolio and a 20/80 one comes out to a little more than half a percent a year (even though the arithmetic average return is 130 basis points higher, the added volatility eats into your CAGR). In return for this half a % per year of return, you taking 2.42 times the risk (going from a standard deviation of 5.6% to 13.6%, a 142% increase). Now, it's true that this half a % adds almost 30% to your total returns over a 30 year investment period, but there are substantially better ways to increase your returns and assume more risk than over-weighting stocks so dramatically.

EDN wrote:Now, if you want to make the case that a 30/70 (TSM/TBM) today represents the best allocation for retirees with the general objectives I stated, I'd be very interested in hearing it.

Eric, my pleasure.

EDN wrote:When I build a plan for a couple in their early 60s who is retiring/retired, I am aware that one of them might not be living in 10-15 years and the other may be around for the better part of 3 decades -- or neither of those may happen. But we try to prepare for as many realistic "what-ifs" possible. We cannot predict the future so we try to assemble a plan that achieves their ongoing income and legacy objectives (again, most/almost everyone I talk to would like to create multi-generational wealth and don't set out to deplete their assets in their lifetime) and doesn't catch them off guard with a short-term decline so extreme it was completely unexpected. And while we do rely on historical data for its perspective, we also recognize where it falls short today (bond returns are likely to be much lower than historical averages). Its just a process we talk through upfront and on an ongoing basis, as opposed to using some retirement questionnaire and just painting by numbers.

If an "early 60s couple," whose life expectancy runs a combined average 15-25 years (roughly late 70s-late 80s), wants to meet ongoing income and legacy objectives:

First they should have MUCH more than 25 x need in savings. To believe that with inadequate savings that 30/70 TSM/TBM - or ANY other allocation - is somehow "the best allocation," is just crazy-talk.

Now, say this couple withdraws 2.5% annually, then a 30/70 TSM/TBM may certainly help them meet objectives.

That said, BUT since we can't "predict the future" as noted, anything else is simply based on guesstimates and conjecture.

Note: I didn't have a chance to thoroughly read through Akiva's postings.

YDNAL wrote:If an "early 60s couple," whose life expectancy runs a combined average 15-25 years (roughly late 70s-late 80s), wants to meet ongoing income and legacy objectives:

First they should have MUCH more than 25 x need in savings. To believe that with inadequate savings that 30/70 TSM/TBM - or ANY other allocation - is somehow "the best allocation," is just crazy-talk.

Now, say this couple withdraws 2.5% annually, then a 30/70 TSM/TBM may certainly help them meet objectives.

That said, BUT since we can't "predict the future" as noted, anything else is simply based on guesstimates and conjecture.

Note: I didn't have a chance to thoroughly read through Akiva's postings.

The problem with this thread is that it morphed into "Legacy Objectives" instead of simple portfolio survival. Legacy Objectives are a whole other topic and were never part of SWR Studies..... So why are we still discussing them ?

25 x Annual spending needs for 25 years survives just fine. (Backward Looking, as No One Can Look Forward).....Not crazy talk!

If an "early 60s couple," whose life expectancy runs a combined average 15-25 years (roughly late 70s-late 80s), wants to meet ongoing income and legacy objectives:

First they should have MUCH more than 25 x need in savings. To believe that with inadequate savings that 30/70 TSM/TBM - or ANY other allocation - is somehow "the best allocation," is just crazy-talk.

Now, say this couple withdraws 2.5% annually, then a 30/70 TSM/TBM may certainly help them meet objectives.

That said, BUT since we can't "predict the future" as noted, anything else is simply based on guesstimates and conjecture.

Note: I didn't have a chance to thoroughly read through Akiva's postings.

Landy,

What you have done is change the circumstances to fit your 30/70. I asked you to explain how that allocation would work under the situation I mentioned. Of course it doesn't, so that probably can be agreed upon and set aside. Now, to focus on your comments, here are the glaring issues with what you said:

1. You don't PLAN for someone's average life expectancy. You HOPE they don't live longer than expected. But you PLAN that they will live longer -- thats the risk. That means at least one member of a couple living to 90 or 95. May not happen, but a plan that doesn't account for it is faulty from the start.

2. You think investors should have MUCH MORE than 25X annual income in a portfolio? At a $40K requirement, that is over $1,400,000 -- not likely. I'd guess that something like single-digit percentages of retirees have been able to save enough to where their annual withdrawal rate is about 2.5%. So this "typical" example is the farthest thing from...

The other thing is -- it isn't necessary. Unless the future turns out to be wildly different from the past, an investor with a balanced portfolio like the ones I mention would have been more than able to generate a lifetime of income and a handsome legacy at 25X savings--even starting in 2000 or 2008 thus far. Of course, that won't be as easy in the future because bond yields are lower and fixed income returns will be below average...but now we are just back to my original point about the challenges of high-bond retirement portfolios.

3. Now lets talk about that 2.5% withdrawal rate. Because more than one retiree has put pen to paper in their last few working years and assumed they would be able to live on a certain minimal budget that would be fairly stable. But then life happens -- our idea of an ideal retirement changes, and sometimes circumstances present themselves that are out of our control. There are an almost infinite number of possibilities for why planned on income is far less than what is actually desired or needed. And unfortunately, when you run your portfolio to the edge in terms of low risk/low return, you have no room for error, another flaw in your thinking. In reality, withdrawal rates might need to be higher, and withdrawal growth may need to be much higher. We saw two decades of inflation north of 6% per year, and that is before additional standard of living increases. That may not happen, but when planning, you need to incorporate such considerations.

4. Finally, what are we thinking on the legacy front? Nothing or next to nothing? At that allocation, its possible (assuming a 25-30 year retirement and 4% adjusted withdrawals). Problem here is, people change. Families move away, you don't see kids/grandkids as much as you'd like, so you start wanting to plan more vacations, become more involved with schooling assistance, and all the things that are important to families. Next thing you know, it becomes a real important objective to contribute financially during and after your life in a meaningful way. But a bare-bones portfolio doesn't account for this either. Might one never come around to finding these things important? Maybe, maybe not, but some change of heart should also be included in the plan.

So right there, off the top of my head, we see why these ultra-conservative portfolios that try to wring out every last ounce of volatility simply don't fit with most retirees, and wind up leaving many overly exposed to many other risks they haven't fully considered or would rather not take.

Like I said, for some retirees in some circumstances (no longevity risk, much greater portfolio balance/income needs than necessary, priority on low volatility and no interest in much of anything else), almost any allocation can fit. But to assume this is the typical or average or how anyone should plan is bad policy.

If an "early 60s couple," whose life expectancy runs a combined average 15-25 years (roughly late 70s-late 80s), wants to meet ongoing income and legacy objectives:

First they should have MUCH more than 25 x need in savings. To believe that with inadequate savings that 30/70 TSM/TBM - or ANY other allocation - is somehow "the best allocation," is just crazy-talk.

Now, say this couple withdraws 2.5% annually, then a 30/70 TSM/TBM may certainly help them meet objectives.

That said, BUT since we can't "predict the future" as noted, anything else is simply based on guesstimates and conjecture.

Note: I didn't have a chance to thoroughly read through Akiva's postings.

Landy,

What you have done is change the circumstances to fit your 30/70. I asked you to explain how that allocation would work under the situation I mentioned.

Eric,

First, you purposedly omitted above "the situation" as I read it.

EDN wrote:When I build a plan for a couple in their early 60s who is retiring/retired, I am aware that one of them might not be living in 10-15 years and the other may be around for the better part of 3 decades -- or neither of those may happen. But we try to prepare for as many realistic "what-ifs" possible. We cannot predict the future so we try to assemble a plan that achieves their ongoing income and legacy objectives (again, most/almost everyone I talk to would like to create multi-generational wealth and don't set out to deplete their assets in their lifetime) and doesn't catch them off guard with a short-term decline so extreme it was completely unexpected. And while we do rely on historical data for its perspective, we also recognize where it falls short today (bond returns are likely to be much lower than historical averages). Its just a process we talk through upfront and on an ongoing basis, as opposed to using some retirement questionnaire and just painting by numbers.

Second, a 2000 word [guesstimate] response notwithstanding, you should indeed do what you need to in order to carry-out fiduciary responsibility "to build a plan for a couple in their early 60s...."

Third, I answered the question with suggestions to hold a lower-Equity allocation to help meet "income + legacy objectives," - the answer that I highlighted above (quote) in blue and repeat here.

....60/40 is sort of a starting point for me when I meet with someone new and am thinking about what my recommendations will be -- 60/40 seems to work well for a wide variety of what I think are "typical retirees" (a 3 decade retirement wishing for about 4% per year and the desire to leave portfolio to next generation). Less in stocks if they don't need as much income or don't have any legacy goals. More in stocks is they put a greater emphasis on growing the bequest.

I find it helpful to start somewhere and adjust upward/downward according to objectives than be all over the map or start with all-bonds and always work up to a better mix.

I already covered the scenario where they want to work longer or want less income (a different assumption), so you reconstructing that case when I asked you to tell us how a 30/70 was the ideal allocation for a 3 decade retirement of 4% plus rising prices and a bequest doesn't do it.

....60/40 is sort of a starting point for me when I meet with someone new and am thinking about what my recommendations will be -- 60/40 seems to work well for a wide variety of what I think are "typical retirees" (a 3 decade retirement wishing for about 4% per year and the desire to leave portfolio to next generation). Less in stocks if they don't need as much income or don't have any legacy goals. More in stocks is they put a greater emphasis on growing the bequest.

I find it helpful to start somewhere and adjust upward/downward according to objectives than be all over the map or start with all-bonds and always work up to a better mix.

I already covered the scenario where they want to work longer or want less income (a different assumption), so you reconstructing that case when I asked you to tell us how a 30/70 was the ideal allocation for a 3 decade retirement of 4% plus rising prices and a bequest doesn't do it.

I'll assume you agree with me.

Eric

Eric,

First, this is what you asked ME specifically (lets not add to it).

EDN wrote:Landy,

There is nothing inconsistent about the viability (or lack there-of) of a particular allocation for general objectives while also specifying that not everyone has those general objectives, and therefore the conclusions don't hold for everyone.

Now, if you want to make the case that a 30/70 (TSM/TBM) today represents the best allocation for retirees with the general objectives I stated, I'd be very interested in hearing it.

Third, the one thing (perhaps our brains think differently) from the first part of your response is that I wouldn't conclude "doesn't do it" since I do NOT know that [and neither do you]. Instead, I would caution that this lofty goal has greater potential to fail in meeting ALL objectives.

A good reason to invest in bond funds at an earlier age is to learn by experience how bond funds react to different investing environments. Actually owning something gives you real world knowledge and experience you can't get by just reading. There is just something about actual skin in the game that cannot be replicated.

I have had substantial bond fund investments only since the year 2000. Of course, I had bond funds before then but until I learned about portfolio theory my portfolio was over 90% stocks. It was foolish and I had never been through a bear market before.

Several posters have quoted Benjamin Graham that an investor should never have less than 25% Bonds in a portfolio or less than 25% stocks. There is much wisdom in that statement.

My reaction is that 0% Bonds under age 50 is just too risky. I am not piling into bonds now in part because I have never been through a major bond bear market before. I have about 67% stocks and about 33% bonds and cash.

Why on earth would I do this? I am 33 now and currently 80/20, couldn't bear the risk of all stocks.

Only reason for anyone older than 40 going 100% stocks is greedy or probably didn't save enough in 20s and 30s and now trying to play catch up.

I am not worried about leaving money for the grandkids or kids, only worried about leaving money for wife and myself to retire with and live in peace. I will stick with Vanguard Target Funds, they are heck of alot smarter than me.

It seems as if everyone forgets investing should be simple. All this previous data and stats and this and that, man too much thinking on the brain.

This concept is discussed in Dr. William Bernstein's book, The Four Pillars of Investing, too. I can't remember if there are footnotes in that book and don't have it at hand. If there are, that might point you to the study.

You could be 0% bonds, but that's not very good at risk management. In my view, AA is risk management, or rather achieving the highest risk-adjusted return possible. 100% equities does not fit that goal. Many studies show a better return with bonds. If nothing else, the bond (read: lower correlation part of your portfolio) allow you to rebalance and buy those stocks on their "corrections."

Keep your powder dry & stay the course!

I'm only 15% bonds (4% TIPs, 11% Bar AGG bond). I view this as the least amount of bonds, regardless of age or risk tolerance / need. I'm very aggressive, but am 41, have a working professional spouse, just retired from the reserves and save like a madman. I also view volatility as noise, a guy playing with a yo-yo while riding an escalator up.

The flip side to this would be question: should a 90 yo investor be 0% equities? This is bad too, for the same reason (albeit more obvious to see).

FWIW, I think it is very worthwhile for even the youngest most aggressive investor to hold a small amount of bonds. It will help the investor develop the discipline to rebalance and stick to a plan when crises hit and correlations go to 1. Over the long run I think building these financial muscles will pay off and make up for a less than 100% equity allocation.

am wrote:Thought 80/20 has a better risk adjusted return, plus you can get some additional return from rebalancing.

Does anyone knows where I can read this study about 80/20 having better risk adjusted return? Thanks!

Jay:

I don't have the "study" in front of me, but I have read studies and statements claiming 80/20 beats 100% stocks. Take it with a grain of salt.

I have no doubt that during specific periods (when certain type bonds outperformed) and with specific rebalancing periods, that there were many periods when 80% stocks/20% bonds had a higher return than 100% stocks. However, I suspect that over long periods and without rebalancing, 100% stocks had the highest return (and highest volatility). The Vanguard "pie charts" show this:

jay22 wrote:Does anyone knows where I can read this study about 80/20 having better risk adjusted return? Thanks! (my emphasis)

It relates to "optimal allocation" on the efficient frontier with best return for the amount of risk taken. Below is a simple chart showing Asset A with ~5% return and Asset B with ~15% return, where the optimal allocation is found at X by combining Assets A & B. Simply substitute A = 100% Bonds and B = 100% Stocks.